How Actual Nuts and Bolts Are Bringing Down Oil Prices

(Bloomberg) -- Last spring, Statoil ASA announced it had used the same oil well design and components to drill three reservoirs for the price of one.

While the specs for Norwegian Sea drilling might provoke reactions akin to the oil field’s name—the Snorre—such standardized pipes and casings could hold the key to a pervasive mystery about today’s energy market: Why is everyone still drilling when prices are in the basement?

Even as oil producers have planned $1 trillion worth of spending reductions between 2015-to-2020—cutting staff, delaying projects, and squeezing contractors—they’ve continued to green-light new wells from the Norwegian Sea to Brazil, and from Uganda to the Gulf of Mexico. Those initiatives mean oil production will continue to grow, adding to the supply glut and putting downward pressure on prices. 

It’s a development that has both baffled and frustrated the world’s biggest producers of crude, who have been waiting for lower prices to force a rollback of global production. They have largely blamed the resilience of the world’s oil drilling on U.S. shale producers, as well as efforts to maintain market share, but the Snorre and other projects like it suggest there may be another–much more boring–culprit at fault.

That's because oil majors' urgent mission to slash costs includes standardizing the components used in drilling for oil–a development that has helped turn unprofitable wells into moneymakers, protected bottom lines, and allowed companies to keep pumping even in the face of crude prices that have more than halved over the past three years.“One might wonder how it is possible that with expenditures being cut dramatically in the upstream industry, output is still growing in many parts of the non-OPEC world while the costs of future projects are declining,” analysts at JBC Energy GmbH wrote earlier this year. “One of the key topics in this respect is industry standardization.”

While oil traders have been pondering the prospect of a production freeze from OPEC, which has so far ramped up production to seize market share and force upstart shale players out of business, they’ve paid scant attention to cooperation already taking place across the industry.

Earlier this year the heads of some of the world’s biggest oil majors, including Saudi Aramco, BP Plc, Repsol SpA, and Statoil, met behind closed doors to discuss a push to cut costs by standardizing the equipment used in exploration and production. Other joint projects are already under way, meaning everything from the ‘Christmas Tree’ collections of valves and spools used in oil wells, to light bulbs, and engineering contracts are now up for standardized treatment.It’s a sharp turnaround from the heady days of the mid-2000s when oil reached more than $145 per barrel. Back then, nascent standardization efforts were primarily aimed at speeding up lead times—the interval between the discovery of oil and when drilling commences—in order to make up for a shortage of engineers and other energy industry professionals.“People were rushing to get hydrocarbons into the market. If something wouldn’t work, you could just throw more money at it,” said Rod Christie, president and chief executive of Turbomachinery Solutions at GE Oil & Gas. “Today that’s not an option. Everything has to be more efficient.”

Now, lead times and costs are again at the fore—but for very different reasons. With the price of oil dipping to $26.21 in February and currently hovering around $45 a barrel, attaining maximum production using the least amount of time and resources is crucial.

“Time is money in this business,” said Kristin Nergaard Berg, DNV GL project manager for a joint industry effort to standardize sub-sea processing. “The earlier you start production, the better the net present value of your project is.”

It’s a far cry from the way things used to be done, when oil companies would often order costly custom fittings tailor-made for individual wells. Ordering standardized parts can allow the firms to pre-stock components and rapidly sign contracts, letting them ramp up production at a faster rate and cheaper cost—similar to the creation of the standardized railway gauges that helped spur a boom in train traffic.

Nergaard Berg estimates that standardization of sub-sea forgings alone—important building blocks for subsea system components—has resulted in a 30 percent reduction in project lead times. Christie, of GE Oil & Gas, also reckons that standardization can lower drilling expenses by an average of 30 percent.

At Statoil, the three wells drilled at its Snorre B platform cost an average 170 million kroner ($21 million) compared with about 490 million kroner for previous projects, according to the Stavanger, Norway-based company. That means oil obtained by the platform, which began pumping some 80,000 barrels a day, costs an average of $10 a barrel.

About 100 miles south of New Orleans, BP has more than halved the costs stemming from a massive floating oil platform known as Mad Dog. While the company is benefiting from a steep reduction in the cost of drilling services and commodities such as steel, a “large chunk of savings has been driven by simplification and standardization,” Goldman Sachs Group Inc. analysts said in research published this month.

“Once FX variations have been factored in, we expect the majority of the projects to be more cost competitive vs. U.S. shale,” the analysts led by Henry Tarr said. “Factoring in the new cost deflation drives breakevens for deepwater the most.”Such standardization efforts are likely unleashing a wave of downward pressure on oil production costs, according to Goldman’s analysis. That’s helped keep expenses low and production high, forcing oil prices lower thanks to the stubborn glut in supply.

“We expect the majority of the projects to be more cost competitive vs. U.S. shale,” the Goldman analysts said, with deepwater drilling to benefit the most from standardization.

Overall, oil majors have taken a chainsaw to expenses, reducing spending for the 2015-to-2020 period by $1 trillion, according to estimates from consulting firm Wood Mackenzie Ltd. 

“The oil industry has often been criticized as being behind other industries in terms of the implementation of available technology,” said the analysts at JBC. “This is beginning to change.”